Two incredibly troubled economies have the world’s hottest stock markets

The currency is collapsing. Inflation is running rampant. Basic items such as milk, cooking oil and toilet paper are in such short supply that people have turned to rationing.

Sound like an ideal environment for stock market investing?

Apparently, judging by Venezuela's benchmark Caracas Stock Exchange index, which is up more than 40% since the end of June. Running a relatively close second to Venezuela is Argentina another South American economy that might charitably be described as a basket case.

What's going on here? Well, we're looking at these stock markets in local currency terms. In other words, if you were a foreign investor your return wouldn't be nearly that big, (That said, even in official US dollar terms, Venezuelan and Argentinian stocks are up 27% and 24% respectively. The real run up is probably somewhat less, however, given weaker black market exchange rates.)

Finance experts have long been at odds over what impact inflation should have on stock markets. Traditional theory long held that equities should rise in inflationary periods as people use them as an inflation hedge (the thinking being that they’re real assets representing claims on real businesses that buy and sell in current prices).

Subsequent studies, such as this one, found very little evidence that actually happens. And many studies have found that stocks actually fall during periods of inflation. Interestingly, it seems that in the heterodox economies of Argentina and Venezuela, the traditional theory of a flight to real assets is holding up pretty well.